10-Q 1 d10q.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended September 30, 2001 Commission File No. 0-10852 SOUTHERN BANCSHARES (N.C.), INC. -------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 56-1538087 --------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 121 East Main Street, Mount Olive, North Carolina 28365 -------------------------------------------------- ----- (Address of Principal Executive offices) (Zip Code) Registrant's Telephone Number, including Area Code: (919) 658-7000 -------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __ -- Indicate the number of shares outstanding of the Registrant's common stock as of the close of the quarter covered by this report. 114,594 shares Part I - FINANCIAL INFORMATION Item 1 - Financial Statements

The accompanying notes are an integral part of these consolidated financial statements. 2

The accompanying notes are an integral part of these consolidated financial statements. 3 SOUTHERN BANCSHARES (N.C.), INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (Dollars in thousands except per share data) (Unaudited)

The accompanying notes are an integral part of these consolidated financial statements. 4 SOUTHERN BANCSHARES (N.C.), INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these consolidated financial statements. 5 SOUTHERN BANCSHARES (N. C.), INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 1. Summary Of Significant Accounting Policies Basis of Financial Statement Presentation Southern BancShares (N. C.), Inc. ("BancShares") is the holding company for Southern Bank and Trust Company ("Southern"), which operates 48 banking offices in eastern North Carolina, and Southern Capital Trust I (the "Trust"), a statutory business trust that issued $23.0 million of 8.25% Capital Securities ("the Capital Securities") in June 1998 maturing in 2028. BancShares irrevocably and unconditionally guarantees the Trust's obligations. Southern, which began operations January 29, 1901, has a wholly-owned subsidiary, Goshen, Inc. which acts as agent for credit life and credit accident and health insurance written in connection with loans made by Southern. BancShares and Southern are headquartered in Mount Olive, North Carolina. The consolidated financial statements in this report are unaudited. In the opinion of management, all adjustments (none of which were other than normal accruals) necessary for a fair presentation of the financial position and results of operations for the quarters presented have been included. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the reporting periods. Actual results could differ from those estimates. The statements should be read in conjunction with the consolidated financial statements and accompanying notes for the year ended December 31, 2000, incorporated by reference in the 2000 Annual Report on Form 10-K. Principles Of Consolidation The consolidated financial statements include the accounts of BancShares and its wholly-owned subsidiaries, Southern and the Trust. The statements also include the accounts of Goshen, Inc., a wholly-owned subsidiary of Southern. BancShares' financial resources are primarily provided by dividends from Southern. All significant intercompany balances have been eliminated in consolidation. 6 Cash And Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash, due from banks and federal funds sold. Federal funds are purchased and sold for one day periods. New Accounting Standards In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement 133, "Accounting for Derivative Instruments and Hedging Activities, as further amended by Statement of Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133, " (collectively referred to herein as "Statement 133"). This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. BancShares adopted this statement on January 1, 2001 with no material impact to the Company's consolidated financial statements. In July 2001, the FASB issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also specifies the criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. Statement 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 will also require that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with FAS Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. At this time BancShares has not determined what effect that the adoption of SFAS No. 141 and 142 will have on the consolidated financial statements. Reclassifications Certain prior year year-to-date and quarter-to-date balances have been reclassified to conform to the current period presentation. Such reclassifications had no effect on net income or shareholders' equity as previously reported. SOUTHERN BANCSHARES (N.C.), INC. AND SUBSIDIARIES Notes to consolidated financial statements Dollars in thousands

7 During the nine months ended September 30, 2000, management of BancShares reviewed its portfolio of securities available-for-sale and determined that certain marketable equity securities had declines in their value that were deemed to be other than temporary. Accordingly, BancShares recorded a charge of $855,000 to investment securities gains (losses) during the first quarter of 2000 for this amount and reduced the carrying amount of the related investments accordingly. There is no assurance that future charges to earnings for other than temporary declines in the fair values of these or other investment securities will not be required. Note 4. ALLOWANCE FOR LOAN LOSSES (Dollars in thousands) (Unaudited) Nine Months Ended September 30, ---------------------------------- 2001 2000 --------------- --------------- Balance at beginning of year $7,284 $6,188 Provision for loan losses 650 300 Loans charged off (395) (301) Loan recoveries 220 263 Sale of credit card portfolio (95) - --------------- ----------- Balance at end of the period $7,664 $6,450 =============== =========== Note 5. Earnings Per Common Share Earnings per common share are computed by dividing income applicable to common shares by the weighted average number of common shares outstanding during the period. Income applicable to common shares represents net income reduced by dividends paid to preferred shareholders. Since BancShares had no potentially dilutive securities during 2001 or 2000, the computation of basic and diluted earnings per share is the same. The following table presents the components of the earnings per share computations:

Note 6. Related Parties BancShares has entered into various service contracts with another bank holding company (the "Corporation") and its subsidiary. The Corporation has two significant shareholders, who also are significant shareholders of BancShares. The first significant shareholder is a director of BancShares and, at September 30, 2001, beneficially owned 32,607 shares, or 28.45%, of BancShares' outstanding common stock and 4,966 shares, or 1.37%, of BancShares' outstanding Series B preferred stock. At the same date, the second significant shareholder beneficially owned 27,522 shares, or 24.02%, of BancShares' outstanding common stock. These two significant shareholders are directors and executive officers of the Corporation and at September 30, 2001, beneficially owned 2,529,991 shares, or 28.71%, and 1,452,494 shares, or 16.48%, of the Corporation's outstanding Class A common stock, and 649,188 shares, or 38.28%, and 199,052 shares, or 11.74%, of the Corporation's outstanding Class B common stock. The above totals include 478,728 Class A common shares, or 5.43%, and 104,644 Class B Common shares, or 6.17%, that are considered to be beneficially owned by both of the shareholders and, therefore, are included in each of their totals. 8 A subsidiary of the Corporation is First-Citizens Bank & Trust Company ("First Citizens"). In the fourth quarter of 2000 Southern acquired two Rocky Mount, North Carolina offices and one Nashville, North Carolina office of First Citizens containing $66.1 million of deposits and $75.8 million of loans. Southern paid $6.7 million to First Citizens for this acquisition. In May 2001 Southern sold its $3.2 million credit card portfolio to First Citizens, recording a gain of approximately $250,000 on the sale. Southern continues to offer its customers a credit card with the Southern Bank brand through First Citizens but the loans are owned by First Citizens. The following table lists the various charges paid to the Corporation during the nine months ended September 30, 2001 and the nine months ended September 30, 2000 in accordance with the aforementioned service contracts:

9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. SOUTHERN BANCSHARES (N.C.), INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - NINE MONTHS ENDED 2001 VS. NINE MONTHS ENDED 2000 INTRODUCTION In the first nine months of 2001, the net income of BancShares increased approximately $3.6 million from $3.0 million in the first nine months of 2000 to $6.6 million in the first nine months of 2001, an increase of 119.15%. This increase resulted primarily from $4.6 million of gains on available-for-sale securities in 2001, and an $855,000 adjustment for unrealized investment security losses, considered other than temporary, to reduce the carrying values of certain marketable equity securities in the first nine months of 2000, that did not recur in 2001. One branch acquisition in February 2000, three branch acquisitions in April 2000, the opening of one new branch in September 2000 and three branch acquisitions in November 2000 resulted in increased net interest income, increased other noninterest income, increased personnel expense and other related operating expenses for the nine months ended September 30, 2001. Per share net income available to common shares for the first nine months of 2001 was $55.41, an increase of $32.19, or 138.63%, from $23.22 for the first nine months of 2000. The annualized return on average equity increased to 11.76%, for the period ended September 30, 2001, from 7.33% for the period ended September 30, 2000. At September 30, 2001, BancShares' assets totaled $856.1 million, an increase of $52.7 million, or 6.55%, from the $803.4 million reported at December 31, 2000. During this nine month period, cash and due from banks decreased $5.1 million, or 11.95% from $42.9 million to $37.8 million. During this nine month period, overnight funds sold increased $29.9 million, or 232.98% from $12.8 million to $42.8 million. During this nine month period, loans increased $49.3 million, or 9.93%, from $497.0 million to $546.3 million. During the nine months ended September 30, 2001 investment securities decreased $21.1 million, or 10.21% from $207.1 million at December 31, 2000 to $186.0 million at September 30, 2001. Total deposits increased $41.0 million, or 5.87% from $698.5 million at December 31, 2000 to $739.5 million at September 30, 2001. The above changes resulted principally from the seasonal impact of the agricultural markets served by Southern . 10 ACQUISITIONS In February 2000 Southern acquired $1.3 million of loans and $7.1 million of deposits of the Robersonville, North Carolina office of Cooperative Bank for Savings, Inc. In April 2000 Southern acquired $5.1 million of loans and $29.4 million of deposits of the Battleboro, Nashville and Sharpsburg, North Carolina offices of Centura Bank. In November 2000 Southern acquired $75.8 million of loans and $66.1 million of deposits of the Nashville and Rocky Mount, North Carolina offices of First-Citizens Bank & Trust Company, a related party. These acquisitions were accounted for as purchases, and, therefore, the results of operations prior to purchase of the financial institutions are not included in the consolidated financial statements. The proforma impact of the acquisitions, as though they had been made at the beginning of the period presented, is not material to BancShares' consolidated financial statements, however the comparisons of the nine months ended September 30, 2001 to the nine months ended September 30, 2000 are impacted by the above transactions. In September 2000 Southern opened its first Greenville, North Carolina branch. INTEREST INCOME Interest and fees on loans increased $5.9 million, or 21.89%, from $27.0 million for the nine months ended September 30, 2000 to $32.9 million for the nine months ended September 30, 2001. This increase resulted from both overall higher loan portfolio yields and increased balances. Average loans for the nine months ended September 30, 2001 were $522.1 million, an increase of 25.99% from $414.4 million for the prior year period. This increase in average loans was principally the result of the acquisitions discussed. The yield on the loan portfolio was 8.89% for the nine months ended September 30, 2000 and 8.35% in the nine months ended September 30, 2001. Interest income from investment securities, including U. S. Treasury and Government obligations, obligations of state and county subdivisions and other securities decreased $302,000 or 3.61%, from $8.4 million in the nine months ended September 30, 2000 to $8.1 million in the nine months ended September 30, 2001. This decrease was due to a decrease in the volume of average investment securities for the nine months ended September 30, 2001 to $183.0 million as compared to $209.8 million for the same 2000 period. The decrease in volume principally resulted from the loan growth discussed. The yield on investment securities was 5.53% for the nine-month period ended September 30, 2000 and 5.84% for the nine-month period ended September 30, 2001. 11 Interest income on overnight funds sold increased $143,000, or 17.70%, from $808,000 for the nine months ended September 30, 2000 to $951,000 for the nine months ended September 30, 2001. This increase in income resulted from an increase in the average overnight funds sold to $29.2 million for the nine months ended September 30, 2001 from an average of $17.9 million for the nine months ended September 30, 2000. The increase in average overnight funds sold resulted primarily from the acquisitions discussed above. Average overnight funds sold yields were 4.30% for the nine months ended September 30, 2001, down from 5.95% for the nine months ended September 30, 2000. Total interest income increased $5.8 million or 15.90%, from $36.1 million for the nine months ended September 30, 2000 to $41.9 million for the nine months ended September 30, 2001. This increase was the result of a 1 basis point decrease in average earning asset yields and an increase of $101.2 million in average earning assets. Average earning asset yields for the nine months ended September 30, 2001 decreased to 7.57% from the 7.58% yield on average earning assets for the nine months ended September 30, 2000. Average earning assets increased from $633.1 million in the nine months ended September 30, 2000 to $734.3 million in the nine months ended September 30, 2001. This $101.2 million increase in the average earning assets resulted primarily from the acquisitions discussed above. INTEREST EXPENSE Total interest expense increased $2.9 million, or 16.57%, from $17.7 million in the nine months ended September 30, 2000 to $20.6 million for the nine months ended September 30, 2001. The principal reason for this increase was the increase in deposits primarily from the acquisitions discussed above. BancShares' total cost of funds decreased from 4.34% for the nine months ended September 30, 2000 to 4.26% for the nine months ended September 30, 2001. Average interest-bearing deposits were $604.3 million in the nine months ended September 30, 2001, an increase of $91.0 million from the $513.3 million average in the nine months ending September 30, 2000. The increase in interest-bearing deposits was primarily the result of the aforementioned acquisitions. NET INTEREST INCOME Net interest income was $21.3 million for the nine months ended September 30, 2001 and $18.5 million for the nine months ended September 30, 2000. The interest rate spread for the nine months ended September 30, 2001 was 3.31%, an increase of 6 basis points from the 3.25% interest rate spread for the nine months ended September 30, 2000. 12 ASSET QUALITY AND PROVISION FOR LOAN LOSSES For the nine months ended September 30, 2001 management recorded $650,000 as a provision for loan losses. Management made a $300,000 addition to the provision for loan losses for the nine months ended September 30, 2000. Management increased the provision in consideration of loan growth, increased net loan charge offs, increased nonperforming loans and the continued overall slowing of the economy. During the first nine months of 2001 management charged-off loans totaling $395,000 and received recoveries of $220,000, resulting in net charge-offs of $175,000. During the same period in 2000, $301,000 in loans were charged-off and recoveries of $263,000 were received, resulting in net charge-offs of $38,000. For the nine months ended September 30, 2001 $650,000 was added to the allowance for loan losses through charges to the operations of BancShares. The allowance for loan losses accordingly increased $380,000 from December 31, 2000. The following table presents comparative Asset Quality ratios of BancShares: (Unaudited) September 30, December 31, 2001 2000 -------------- ----------- Ratio of annualized net loans charged off to average loans 0.04% 0.04% Allowance for loan losses to loans 1.40% 1.47% Non-performing loans to loans 0.40% 0.31% Non-performing loans and assets to total assets 0.27% 0.19% Allowance for loan losses to non-performing loans 350.76% 467.22% The ratio of annualized net charge-offs to average loans outstanding was 0.04% for both the nine months ended September 30, 2001 and the year ended December 31, 2000. The allowance for loan losses represented 1.40% of loans at September 30, 2001. The allowance for loan losses represented 1.47% of loans at December 31, 2000. The allowance for loan losses to loans ratio was also impacted by the net growth in loans of $49.3 million, or 9.93% from $497.0 million at December 31, 2000 to $546.3 million at September 30, 2001. During the second quarter of 2001 BancShares sold its credit card portfolio which totaled approximately $3.2 million. Credit card loans were considered by management to be one of the highest risk loan types and accordingly had been assigned a high reserve requirement. The allowance related to this portfolio was $95,000 at the time of sale. See footnote 4 to the financial statements for the effect of the sale on the allowance. The ratio of nonperforming loans to total loans increased from 0.31% at December 31, 2000 to 0.40% at September 30, 2001. Nonperforming loans and assets to total assets increased to 0.27% at September 30, 2001 from 0.19% at December 31, 2000. The allowance for loan losses to nonperforming loans represented 350.76% of nonperforming loans at September 30, 2001, a decrease from the 467.22% at December 31, 2000. 13 Performance declines resulted primarily from an increase in nonperforming loans to $2.2 million at September 30, 2001 from $1.6 million at December 31, 2000. The nonperforming loans at September 30, 2001 included $84,000 of nonaccrual loans, $2.1 million of accruing loans 90 days or more past due and $28,000 of restructured loans. The nonperforming loans at December 31, 2000 included $478,000 of nonaccrual loans, $1.1 million of accruing loans 90 days or more past due and no restructured loans. There were no significant impaired loans at September 30, 2001. BancShares had $154,000 of assets classified as other real estate at September 30, 2001. BancShares had no assets classified as other real estate at December 31, 2000. Other real estate is recorded at the lower of cost or fair value less estimated costs to sell. Subsequent costs directly related to development and improvement of property are capitalized, whereas costs relating to holding the property are expensed. Management considers the September 30, 2001 allowance for loan losses to be adequate to cover the losses and risks inherent in the loan portfolio at September 30, 2001 and will continue to monitor its portfolio and to adjust the relative level of the allowance as needed. Management actively maintains a current loan watch list and knows of no other loans which are material and (i) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity or capital resources, or (ii) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms. Management believes it has established the allowance in accordance with accounting principles generally accepted in the United States of America and in consideration of the current economic environment. While management uses the best information available to make evaluations, future adjustments may be necessary if economic and other conditions differ substantially from the assumptions used. In addition, various regulatory agencies, as an integral part of their examination process, periodically review Southern's allowance for loan losses and losses on other real estate owned. Such agencies may require Southern to recognize adjustments to the allowances based on the examiners' judgments about information available to them at the time of their examinations. NONINTEREST INCOME During the nine months ended September 30, 2001, BancShares realized a $6.5 million increase in noninterest income primarily as a result of a gains recorded on the sales of available-for-sale investment securities. 14 During the nine months ended September 30, 2001 investment securities were sold for a net gain of $4.6 million. During the nine months ended September 30, 2000, management of BancShares reviewed its portfolio of securities available-for-sale and determined that certain marketable equity securities had declines in their value that were deemed to be other than temporary. Accordingly, BancShares recorded a charge of $855,000 to investment securities gains (losses) in the accompanying consolidated statement of income and comprehensive income for the nine months ended September 30, 2000 for this amount and reduced the carrying amount of the related investments accordingly. There is no assurance that future charges to earnings for other than temporary declines in the fair values of these or other investment securities will not be required. Service charges on deposit accounts for the nine months ended September 30, 2001 increased $868,000 and other service charges and fees for the nine months ended September 30, 2001 increased $146,000 over the nine months ended September 30, 2000 primarily as a result of the aforementioned acquisitions. NONINTEREST EXPENSE Noninterest expense increased $3.8 million or 21.04%, from $18.1 million in the nine months ended September 30, 2000 to $21.9 million in the nine months ended September 30, 2001. This increase was primarily due to an increase in personnel expense of $1.8 million, or 20.42%, from $8.7 million at September 30, 2000 to $10.5 million at September 30, 2001 and increased occupancy, data processing and other expenses resulting principally from the aforementioned branch acquisitions. INCOME TAXES In the nine months ended September 30, 2001 BancShares recorded income tax expense of $2.3 million. In the nine months ended September 30, 2000, BancShares recorded income tax expense of $800,000. The resulting effective tax rate for the nine months ended September 30, 2001 was 25.99%. The effective tax rate for the nine months ended September 30, 2000 was 20.90%. The estimated effective tax rate was higher in 2001 due to a decrease in tax-exempt income in 2001 as a percentage of total income before taxes. The effective tax rates in 2001 of 25.99% and in 2000 of 20.90% differ from the federal statutory rate of 34.00% primarily due to tax exempt income. 15 SOUTHERN BANCSHARES (N.C.), INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - THIRD QUARTER OF 2001 VS. THIRD QUARTER OF 2000 INTRODUCTION In the three months ended September 30, 2001, the net income of BancShares decreased $68,000 from $1.3 million in the three months ended September 30, 2000 to $1.2 million in the three months ended September 30, 2001, a decrease of 5.17%. The decrease in net income for the quarter ended September 30, 2001 is attributed to an increase in noninterest expenses and the provision for loan losses which were not fully offset by growth in net interest income and noninterest income. In addition, BancShares effective tax rate increased significantly in 2001 compared to 2000. The third quarter 2001 provision for loan losses was higher than the 2000 provision for loan losses, primarily due to loan growth and the continued slowdown of the economy in 2001. Per share net income available to common shares for the three months ended September 30, 2001 was $10.07, a decrease of $0.34, or 3.27%, from $10.41 in the three months ended September 30, 2000. ACQUISITIONS Southern had no acquisitions in the quarter ended September 30, 2000 or the quarter ended September 30, 2001. INTEREST INCOME Interest and fees on loans increased $1.5 million, or 15.85%, from $9.5 million for the quarter ended September 30, 2000 to $11.0 million for the quarter ended September 30, 2001. This increase was due to increased loan balances. Average loans for the quarter ended September 30, 2001 were $543.8 million, an increase of 27.00% from $428.2 million for the prior year quarter. The yield on the loan portfolio was 8.77% for the three months ended September 30, 2000 and 7.96% for the three months ended September 30, 2001. Interest income from investment securities, including U. S. Treasury and Government obligations, obligations of state and county subdivisions and other securities decreased $382,000, or 13.15%, from $2.9 million in the three months ended September 30, 2000 to $2.5 million in the three months ended September 30, 2001. This decrease was primarily due to a decrease in the average investment portfolio resulting from loan growth. Average investment securities for the quarter ended September 30, 2001 decreased to $173.6 million as compared to $212.7 million for the same 2000 quarter. The yield on investment securities was 5.62% for the quarter ended September 30, 2000 and 5.66% for the quarter ended September 30, 2001. 16 Interest income on overnight funds sold increased $59,000, or 29.95%, from $197,000 for the quarter ended September 30, 2000 to $256,000 for the quarter ended September 30, 2001. This increase in income resulted from an increase in volume. Approximately $75.8 million of the volume increase resulted from the aforementioned acquisitions. The average overnight funds sold was $31.2 million for the quarter ended September 30, 2001 compared to an average of $12.0 million for the quarter ended September 30, 2000. Average overnight funds sold yields were 2.92% for the quarter ended September 30, 2001 down from 6.67% for the quarter ended September 30, 2000. Total interest income increased $1.2 million, or 9.39%, from $12.6 million for the quarter ended September 30, 2000 to $13.8 million for the quarter ended September 30, 2001. This increase was primarily the result of an increase in the average earning assets resulting primarily from the aforementioned acquisitions. Average earning asset yields for the quarter ended September 30, 2001 decreased to 7.24% from the 7.73% yield on average earning assets for the quarter ended September 30, 2000. Average earning assets increased from $653.5 million in the quarter ended September 30, 2000 to $748.6 million in the quarter ended September 30, 2001. Approximately $75.8 million of this $95.1 million increase in average earning assets resulted from the aforementioned acquisitions. INTEREST EXPENSE Total interest expense was $6.4 million for both the three months ended September 30, 2000 and the three months ended September 30, 2001. There was no change in interest expense as the impact of the increased balances resulting from the aforementioned acquisitions was offset by decreased costs of deposits and short-term borrowings. NET INTEREST INCOME Net interest income was $7.4 million for the three months ended September 30, 2001 and $6.2 million for the three months ended September 30, 2000. The interest rate spread for the quarter ended September 30, 2001 was 3.36%, an increase of 21 basis points from the 3.15% interest rate spread for the quarter ended September 30, 2000. ASSET QUALITY AND PROVISION FOR LOAN LOSSES For the three months ended September 30, 2001 management recorded $250,000 as a provision for loan losses. Management made a $150,000 provision for loan losses for the quarter ended September 30, 2000. 17 During the three months ended September 30, 2001 management charged-off loans totaling $44,000 and received recoveries of $162,000, resulting in net recoveries for the three months ended September 30, 2001 of $118,000. During the three months ended September 30, 2000, $146,000 in loans were charged-off and recoveries of $95,000 were received, resulting in net charge-offs of $51,000 for the three months ended September 30, 2000. In spite of the net recoveries realized during the quarter ended September 30, 2001, BancShares recorded an increase in the provision for loan losses due to strong loan growth and the effects of the slowing economy on borrowers. NONINTEREST INCOME During the three months ended September 30, 2001, BancShares' noninterest income increased $164,000 principally as a result of the aforementioned acquisitions. Service charges on deposit accounts for the three months ended September 30, 2001 increased $257,000 and other service charges and fees for the three months ended September 30, 2001 increased $45,000 over the three months ended September 30, 2000 primarily as a result of the aforementioned acquisitions. NONINTEREST EXPENSE Noninterest expense including personnel, occupancy, furniture and equipment, data processing, FDIC insurance, state assessments, printing, supplies and other expenses, increased $962,000 or 15.60%, from $6.2 million in the three months ended September 30, 2000 to $7.2 million in the three months ended September 30, 2001. This increase was primarily due to an increase in personnel expense of $578,000, or 19.53%, from $3.0 million for the quarter ended September 30, 2000 to $3.5 million for the quarter ended September 30, 2001 and increased occupancy, furniture and equipment expense and other expenses resulting principally from the aforementioned acquisitions. INCOME TAXES In the three months ended September 30, 2001, BancShares had income tax expense of $690,000, an increase of $350,000 from $340,000 in the prior year quarter. This increase is due to both increased earnings and an increase in the estimated effective tax rate to 35.60% for the quarter ended September 30, 2001 to adjust the estimated year-to-date tax rate to 25.99%. The estimated effective tax rate for the quarter ended September 30, 2000 was 20.53%. The estimated effective tax rate was revised due to a change in management estimates of taxable income for 2001. During the quarter ended September 30, 2001, management determined that tax exempt income would represent a smaller proportion of total income than previously projected. The effective tax rates for the quarters ended 18 September 30, 2001 of 35.60% and September 30, 2000 of 20.53% differ from the federal statutory rate of 34.00% primarily due to tax exempt income. SHAREHOLDERS' EQUITY AND CAPITAL ADEQUACY Sufficient levels of capital are necessary to sustain growth and absorb losses. In June 1998, the Trust issued $23.0 million of 8.25% Capital Securities maturing in 2028. The Trust invested the $23.0 million proceeds in Junior Subordinated Debentures issued by BancShares (the "Junior Debentures"), which upon consolidation of BancShares are eliminated. The Junior Debentures, with a maturity of 2028, are the primary assets of the Trust. BancShares irrevocably and unconditionally guarantees the Trust's obligations. BancShares contributed Capital Securities proceeds of $12.0 million to Southern which are included in Tier I capital for Southern's regulatory capital adequacy requirements. BancShares has similar regulatory capital adequacy requirements as Southern and is in compliance with those capital adequacy requirements at September 30, 2001. The Federal Reserve Board, which regulates BancShares, and the Federal Deposit Insurance Corporation, which regulates Southern, have established minimum capital guidelines for the institutions they supervise. Regulatory guidelines define minimum requirements for Southern's leverage capital ratio. Leverage capital equals total equity less goodwill and certain other intangibles and is measured relative to total adjusted assets as defined by regulatory guidelines. According to these guidelines, Southern's leverage capital ratio at September 30, 2001 was 7.19%. At December 31, 2000, Southern's leverage capital ratio was 6.97%. Both of these ratios are greater than the level designated as "well capitalized" by the FDIC. Southern is also required to meet minimum requirements for Risk Based Capital ("RBC"). Southern's assets, including loan commitments and other off-balance sheet items, are weighted according to federal guidelines for the risk considered inherent in each asset. At September 30, 2001, Southern's Total RBC ratio was 12.51%. At December 31, 2000 the RBC ratio was 12.59%. Both of these ratios are greater than the level designated as "well capitalized" by the FDIC. The regulatory capital ratios above reflect increases in assets and liabilities from the acquisitions Southern has made. Each of the acquisitions required the payment of a premium for the deposits received. Each of these premiums resulted in increased intangible assets on BancShares' financial statements, which is deducted from total equity in the ratio calculations. The accumulated other comprehensive income was $9.9 million at both September 30, 2001 and December 31, 2000. Comprehensive income consists entirely of unrealized gains on securities available-for-sale, net of taxes. Although a part of total shareholders' equity, comprehensive income is not included in the 19 calculation of either the RBC or leverage capital ratios pursuant to regulatory definitions of these capital requirements. The following table presents capital adequacy calculations and ratios of Southern: (Unaudited) September 30, 2001 ------------- (Dollars in thousands) Tier 1 capital $ 58,398 Total capital 68,146 Risk-adjusted assets 544,626 Average tangible assets 812,483 Tier 1 capital ratio (1) 10.72% Total capital ratio (1) 12.51% Leverage capital ratio (1) 7.19% (1) These ratios exceed the minimum ratios required for a bank to be classified as "well capitalized" as defined by the FDIC. LIQUIDITY Liquidity refers to the ability of Southern to generate sufficient funds to meet its financial obligations and commitments at a reasonable cost. Maintaining liquidity ensures that funds will be available for reserve requirements, customer demand for loans, withdrawal of deposit balances and maturities of other deposits and liabilities. Past experiences help management anticipate cyclical demands and amounts of cash required. These obligations can be met by existing cash reserves or funds from maturing loans and investments, but in the normal course of business are met by deposit growth. In assessing liquidity, many relevant factors are considered, including stability of deposits, quality of assets, economy of the markets served, business concentrations, competition and BancShares' overall financial condition. BancShares' liquid assets include cash and due from banks, federal funds sold and investment securities available-for-sale. The liquidity ratio, which is defined as cash plus short term available-for-sale securities divided by deposits plus short term liabilities, was 26.07% at September 30, 2001 and 33.48% at December 31, 2000. The Statement of Cash Flows discloses the principal sources and uses of cash from operating, investing and financing activities for the nine months ended September 30, 2001 and for the nine months ended September 30, 2000. Southern has no brokered deposits. Jumbo time deposits are considered to include all time deposits of $100,000 or more. Southern has never aggressively bid on these deposits. Almost all jumbo time deposit customers have other relationships with Southern, including savings, demand and other time deposits, and in some cases, loans. At September 30, 2001 jumbo time deposits represented 14.36% of total deposits. At December 31, 2000 jumbo time deposits represented 11.69% of total deposits. Management believes that BancShares has the ability to generate sufficient amounts of cash to cover normal requirements and any additional needs which may arise, within realistic limitations, and management is not aware of any known demands, commitments or uncertainties that will affect liquidity in a material way. 20 ACCOUNTING AND OTHER MATTERS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. This statement, as amended by Statements 137 and 138, was effective for all fiscal quarters of fiscal years beginning after June 15, 2000. BancShares adopted this statement on January 1, 2001, with no material impact upon adoption. In July 2001, the FASB issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also specifies the criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. Statement 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 will also require that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with FAS Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. At this time BancShares has not determined what effect that the adoption of SFAS No. 141 and 142 will have on the consolidated financial statements. The FASB also issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of BancShares and monitors the status of changes to issued exposure drafts and to proposed effective dates. OTHER MATTERS Management is not aware of any other trends, events, uncertainties, or current recommendations by regulatory authorities that will have or that are reasonably likely to have a material effect on BancShares' liquidity, capital resources or other operations. 21 Item 3 - Quantitative and Qualitative Disclosures About Market Risk: Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in either diminished current market values or reduced potential net interest income in future periods. BancShares' market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. The structure of BancShares' loan and deposit portfolios is such that a significant increase in the prime rate may adversely impact net interest income. Historical prepayment experience is considered as well as management's expectations based on the interest rate environment and the core deposits without contractual maturity level as of September 30, 2001. Management seeks to manage this risk through the use of shorter term maturities. The composition and size of the investment portfolio is managed so as to reduce the interest rate risk in the deposit and loan portfolios while at the same time maximizing the yield generated from the loan portfolio. The table below presents in tabular form the contractual balances and the estimated fair value of financial instruments at their expected maturity dates as of September 30, 2001. The expected maturity categories take into consideration historical prepayment experience as well as management's expectations based on the interest rate environment as of September 30, 2001. For core deposits without contractual maturity (i.e., interest bearing checking, savings and money market accounts), the table presents principal cash flows as maturing in 2002 since they are subject to immediate repricing. Weighted average variable rates in future periods are based on the implied forward rates in the yield curve as of September 30, 2001. Overall loan and deposit balance maturities are shorter at September 30, 2001 and overall rates have declined significantly, primarily as a result of market conditions and management's responses thereto.

A principal objective of BancShares' asset/liability function is to manage interest rate risk or the exposure to changes in interest rates. Management maintains portfolios of interest-earning assets and interest-bearing liabilities with maturities or repricing opportunities that will protect against wide interest rate fluctuations, thereby limiting, to the extent possible, the ultimate interest rate exposure. The table below provides BancShares' interest-sensitivity position as of September 30, 2001, which reflected a one year negative interest-sensitivity gap of $258.2 million. As a result of this one year negative gap, increases in interest rates could have an unfavorable impact on net interest income. It should be noted that this analysis reflects BancShares' interest sensitivity as of a single point in time and may not reflect the effects of repricings of assets and liabilities in various interest rate environments. The overall one-year interest sensitivity of financial instruments is significantly higher at September 30, 2001 as compared to December 31, 2000. 22 The total cumulative interest sensitivity gap has also increased significantly at September 30, 2001 as compared to December 31, 2000. INTEREST-SENSITIVITY ANALYSIS (Dollars in thousands, unaudited)

Part ii - OTHER INFORMATION Item 5. Other Information. Forward-looking statements The foregoing discussion may contain statements that could be deemed forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act, which statements are inherently subject to risks and uncertainties. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualifiers such as "expect," "believe," "estimate," "plan," "project" or other statements concerning opinions or judgments of BancShares and its management about future events. Factors that could influence the accuracy of such forward-looking statements include, but are not limited to, the financial success or changing strategies of BancShares' customers, actions of government regulators, the level of market interest rates, and general economic conditions. 23 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOUTHERN BANCSHARES (N.C.), INC. November 06, 2001 /s/ John C. Pegram, Jr. ------------------ ------------------------------------------------- Date John C. Pegram, Jr., President and Chief Executive Officer November 06, 2001 /s/ David A. Bean ------------------ ------------------------------------------------- Date David A. Bean, Secretary, Treasurer and Chief Financial Officer 24

SOUTHERN BANCSHARES NC INC 10-Q